What shall we do with Polish power industry?

02.08.2017
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By
Paweł Musiałek

What shall we do with Polish power industry? The biggest problem for energy companies in the implementation of new investment projects is the huge uncertainty of the market situation resulting from regulatory risk, low raw materials prices and the development of RES. A key question in the context of the Polish energy mix is ​​not what will come after carbon but what will accompany

carbon. Undoubtedly, the “black gold” will be the basis of our energy. It should be borne in mind, however, that maintaining the competitiveness of coal in relation to other sources does not necessarily mean that miners in Poland can sleep peacefully. If the Polish mining sector does not undergo profound restructuring, it is likely that coal will be imported from abroad. And it should be the investors who, by choosing more profitable investments, will determine the shape of the energy mix itself, rather than the state whose role should be limited to creating the most favorable conditions for investment.

The aging energy blocs, the construction of the EU single market, or the EU low carbon price do not exhaust the long list of determinants that the government must take into account in developing the concept of Poland’s energy policy for the coming years. The scale of the challenges which our energy industry faces makes it one of the key public policies in the decades ahead. The huge investment needs in Poland, resulting from the need to ensure energy security, would make it difficult to maintain competitive energy prices. It should be emphasized that cheap electricity is not only an important matter for household budgets, but it is also an important factor influencing the competitiveness of our economy. It must also not be forgotten that the problems influencing the energy sector directly affect other sectors, including the mining sector whose main customers are the power plants. The full picture of the challenge is complemented by the fact that, regardless of the condition of Polish energy companies, the mining itself requires radical reforms.

Are we safe?

When examining the condition of the Polish energy industry, it is necessary to start with the issue of energy security. Price or environmental issues are of secondary importance, whereas ensuring the continuity of energy supply remains a fundamental issue. For a long time the discussiom about the threats to Poland’s energy security was dominated by the issue of the diversification of natural gas supplies (security of oil supplies has not been a threat for years), which until recently was almost entirely imported from Russia. Nowadays, due to the construction of the LNG terminal in Świnoujście, the construction of connections within the North-South Corridor, the development of the EU gas market through the harmonization of regulations and, above all, the possibility of returning supplies from Germany, the security of gas supply is no longer a major challenge.

Unfortunately, at the moment our country has to deal with a new threat to the security of electricity supply resulting from the need to close high-powered power units built in the communist era (by 2020, 6,000 MW of old advanced power plants will have to be shut down). Thus, a safe period, in which we used a powerful infrastructure built for the energy-intensive economy of communist Poland, is coming to an end. Considering the expected economic growth, which is strongly correlated with the increase in energy demand and the lack of adequate investment in new power units, the situation is not optimistic. The prelude to this threat was last year when the 20th power was announced and some companies had limited energy supplies, which translated into measurable losses for the Polish The prelude to this threat could be observed last year when the 20th power supply level was announced and some companies had limited energy supplies, which translated into measurable losses for the Polish economy.

On a precarious market

The biggest problem for energy companies in the implementation of new investment projects is the huge uncertainty of the market situation resulting from regulatory risk, low raw materials prices and the development of RES. Power industry is a field which strongly regulated by the state and is therefore very sensitive to the changes in law. In the meantime, works on laws that will determine the shape of the Polish power industry have been underway for several years, and no one can predict what their final effect will be, as various interests are colliding in the area. Apart from the lack of government decision-making, there is another problem, namely, the strong link between energy and the EU’s climate and environmental policies. The final shape of the new 2030 energy and climate package is still not known, which creates uncertainty regarding the costs that energy companies will incur for this reason. Detailed regulations are still being prepared, so many companies are holding back their investments, waiting for developments.

Secondly, investments in energy units are long-term, and while analyzing the profitability of a given investment investors should consider not only the current market situation, but also the situation in 5,10 and even 30 years’ time. Such a distant time horizon in the context of uncertainty and dynamic changes in the broadly understood energy sector poses enormous risks not only for energy companies, but primarily for financial institutions thatgive loans to finance the new projects, especially as energy blocks are very expensive (eg power plant construction in Opole costs about 10 billion zlotys). Some banks no longer want to finance coal investments because they do not see them as profitable in the long run.

It is also worthwhile to realize that planning the energy mix up to 2050, which the last government document is attempting to do, is not so much unrealistic as it is almost completely impossible. Just like more than a decade ago no one imagined, for example, the shale revolution, and five years ago no one predicted the current prices of raw materials, so today we can not predict where new technologies will lead us in the near future. There are three particularly significant megatrends, though the revolution still extends beyond them. First of all, we observe the increase in energy efficiency, secondly the development of energy storage, the thirdly development of electric cars. 20 years is absolutely the period for which we are able to make realistic assumptions regarding energy policy.

Apart from regulatory risk, the second key uncertainty is the price of raw materials. We are currently dealing with very low prices of all raw materials as a result of their oversupply due to, among others, shale revolution, deceleration of growth in Chinese economy or development of RES. The crucial issue for the Polish energy industry are very low coal prices, which have been in place for several years and there is no prospect of a change in this trend. Because of the increase of renewable energy sources, and the fact that new coal-fired power plants are much more efficient (about 45 %) than the old ones (30%),

which means that they will need less fuel. At present, few power plants earn zero profit and this raises the risk of many unprofitable investments in new power units. According to experts, the break-even point for coal-fired power plants is PLN 200 per megawatt-hour in the wholesale market, while today the energy supply contracts for the next year are about PLN 160. Out of the impressive list of projects of new coal blocks only three are currently being implemented – power plants in Opole, Kozienice and Jaworzno. It is no coincidence that the investors are Polish treasury companies. Many experts point out that it was the government’s determination regarding the construction of new blocks that was crucial because economic analyzes were not optimistic. This is confirmed by the fact that the remaining planned investments by other companies have been suspended. The history of the power plant project in Opole is also symptomatic. Former CEO of PGE (investor) Krzysztof Kilian had to step down because he did not want to build an unprofitable power plant. Strangly enough, his successor Marek Woszczyk counted again and … it turned out that the power plant could be somehow profitable. It should not surprise us – he voters will not be interssted in the low price of companies’ shares, but they would be definitely upset with blackouts.

Other blocks which would fall out of the system will put pressure on the price increase, but before investors receive the market signal and new investments will be built and connected to the network, the threat to security of energy supply will be very large, because demand and supply for energy in Poland in the period of change will be almost equal.

But there is no need to panic. Poland is not in danger of experiencing a blackout on a large scale. There are two rescue mechanisms in use which PSE – the Polish power grid operator can resort to: the first is the operational power reserve (the operator pays to the owners of blocks whose operation is unprofitable for not shutting them off for the safety of the whole power system), the second is the intervention reserve (The operator pays the owner of the blocks for their maintenance readiness to run at the operator’s command during the expected power shortages.)

The continued uncertainty will, however, result in a threat in the long run, when the next blocks will be closed and new ones will not appear. The response to this problem currently proposed by energy companies is the introduction in Poland of the so-called power market. This mechanism means that the investor will be paid not only for the sale of energy, but also for the power plant’s readiness to produce it. The power market is thus a mechanism aiming at reducing the risk of the lack of profitability of new power units. In this way, energy companies will be able to show the profitability of their investments to credit institutions. Without a power market, the construction of new units is very risky, although the new law allows us to ask a question whether the introduction of an auction system where supporting certain technology or sources is prohibited (the EU requirement) will give conventional power plants such support to make their projects profitable. One can be sure that at current prices, new blocks will not provide a return on investment, let alone any margin. The problem with the construction of the power market is not only the additional burden on energy consumers, which is in fact a tax on energy security. The European Commission shows great resistance to this mechanism because if each state pays a diffrent subsidy to power plant operators, it will impede the construction of a single EU energy market, which is one of the priorities of the Union’s energy policy. Another debatable issue is that the power market, or subsidies to conventional energy, are the consequence of subsidies to RES. This raises the obvious question about the reasonableness of such a mechanism. So far no one has found the way out of this spiral of regulations.

What energy mix?

The second key question regarding energy policy is the question of the target desired energy mix. The lobby of individual energy sectors argues for the superiority of coal, gas, atoms, or RES over other sources of energy. There is a lot of money involved, so in the public debate we can observe the collision of different reports where each side selectively chooses particular figures to prove their points. The key question in the context of the Polish mix is not what will come after coal, but what will we introduce apart from coal? Undoubtedly,the “black gold” will be the basis of our energy. This is due to the fact that coal-fired power plants and CHPs are the dominant sources of energy for the Polish power system and many of them are ready for operation for several decades. Besides, we have significant reserves of coal, which means that, we do not have to import it unlike other raw materials.

It is widely believed that the ideal energy mix should be as varied as possible. The countries where the mix looks like a perfectly different colored “circle” are often considered to be the model for other countries to follow. While undoubtedly the diversification of energy sources enhances energy security, it is important to ask whether this is a reasonable cost. Subsidizing green energy or building an expensive nuclear power plant means increasing energy prices, which will soon increase significantly anyway, due to the need for infrastructure investments I mentioned earlier. Therefore, from the point of view of energy prices, the most optimal solution would be to leave the energy mix to market mechanisms. It should be up to investors to shape the mix by choosing more profitable investments and the role of the state should be limited to creating the most favorable investment conditions. Another reason why the choice of energy mix in advance for several decades is problematic is technological development, which in the energy sector is very dynamic and whose nature is unpredictable. The best example of how technology can substantially disrupt government plans is the shale revolution in the US. Over the decade, the United States from a large importer has become a gas exporter, and import terminals that cost billions of dollars are being converted to export terminals.

The main conclusion that can be drawn from the situation which has taken place overseas is that determining which energy source to use is very hard. The Polish government should, of course, make forecasts for energy demand, but these forecasts should be adapted to reality, not the other way round. When asked whether we should invest in gas, coal, RES or government atom, the government should respond – ask investors which sources of energy they consider the most attractive. Just as the government does not decide whether to use butter or margarine, it should not decide whether to use gas or renewable energy. From the point of view of the government, it is crucial to ensure that the demand for energy is covered, yrt the source of energy is secondary. This solution is not only the cheapest, but also the most fair. The one who will be able to produce the cheapest energy will win, which would be in line with the idea of ​​increasing the competitiveness of the Polish economy and not the one who will gain the advantage in the form of subsidies or favorable regulations. This mechanism should apply to the competition between coal, gas, RES and atom, but also between individual sub-sectors of RES, ie wind, sun or biomass.

Leaving the market the freedom to shape the mix is ​​also important because of the idea of ​​building a single EU energy market. Getting rid of the barriers in the flow of electricity between states will result in the national current being displaced by imports. Due to high enrgy prices, domestic energy companies will be at a risk of losing customers to foreign competitors. Maintaining low prices by limiting interventions in the market mechanism would make the single market a threat, but not an opportunity for Polish energy exports

Such a solution must contain some important stipulations. First of all, Poland committed itself to raising the share of RES in the energy mix up to 15% by 2020 and the next package agreed at the 2014 European Council will oblige us raise the level of energy. Poland must therefore introduce a mechanism for enforcing this level if the market itself does not generate the right amount of investment. In order to achieve this goal the state should introduce an auction system, whereby the state will subsidize those green investments that will require the lowest subsidy to meet EU requirements.

The second major concern is the need to reduce investment risk, so that any investment is made at all. This requires the adoption of a cross-party energy doctrine that will continue through successive governments, at least with regards to key mechanisms, in order to preserve the stability of the main objectives and thus the regulations.

The third stipulation concerns the supporting role of RES. As a result of the instability of the energy supply of these sources, resulting from changing weather conditions, regardless of the cost of generating energy “green” installations will be complementary to carbon / gas / nuclear units. Every megawatt of RES power must be covered 1 megawatts from “secure” sources, which raises the question of the possibility of the target basingof the whole energysystem the RES . It should also be borne in mind that 1 MW of wind farms does not equal 1 MW from coal-fired power plants, because the average utilization rate is less than 30%. Until a large-scale storage of energy is invented, in Poland, but also in other countries, there is no chance that wind or photovoltaic energy would replace carbon / gas / atomic energy as the basis of the system. It is impossible to maintain two different energy systems – heavily subsidized renewable and conventional energy, because the latter will not be profitable if it will work only as a supplement to RES.

The marketization of the energy mix would mean that coal power plants would in the near future supersede both gas and nuclear power stations. Also RES would not develop without subsidies. This is due to very low coal prices on the market. However, it should be borne in mind that raw material prices are not fixed and that mutual competitiveness may change. It will be affected not only by supply and demand factors, but also by the prices of CO2 allowances, which are the quasi-tax paid by coal-fired power plants. Today, these prices are low, but soon the European Commission may administratively interfere in the market valuation mechanism and then the cost of carbon production will be higher than the production gas or nuclear energy.

Miners can not sleep peacefully

It must be borne in mind that maintaining the competitiveness of coal in relation to other sources does not necessarily mean that miners in Poland can sleep peacefully. If the Polish mining sector is not subject to profound restructuring, it is likely that coal will be imported from abroad. This is not a threat to energy security, as the coal market is liquid, but it will be a problem for all mining subsectors who keep their domestic production alive. Obviously, in order to rescue the miners, the state may block all imports or force Polish companies to purchase Polish coal, which would mean weakening the competitiveness of the Polish power industry, which will be forced to buy more expensive Polish coal. Such attempts have been made, not without success. Reforms required by the Polish mining industry must be very profound, given that at the current coal price (the ARA price in 2015 was $ 57 per tonne, and $ 120 per tonne in 2011), the vast majority of Polish coal mines are unprofitable, which raises costs for the whole economy. Unfortunately, the idea of ​​creating the Polish Mining Group seems to be the connection to the IV, not a comprehensive solution to the main problem of maintaining unprofitable mines and too high costs in prospective plants. Unfortunately,however, this drip comes largely from the energy sector, which significantly limits the investment opportunities of Polish power generation companies.

Looking for positive aspects, it is worth emphasizing that Polish coal can be mined in a profitable manner. To prove this point, it is enough to look not only at the prosperous Polish mines, but also at the fact that private Czech companies have already invested in Poland (NWR has invested in the Debeńsk deposits and the EPH holding has bought from Silesian coal mine Kompania Węglowa) and concessions were granted to companies from Australia. Competition on the part of private companies is needed to increase pressure on state mines to increase efficiency.

The clock is ticking

The scale of challenges facing the Polish energy industry is enormous and it is not very comforting that other countries are not in a better situation than Poland. Moreover, although the number of unknowns does not decrease, the time of careful anticipation for the development of the situation ends. If Polish politicians are not be able to find the way of providing energy security, estimating the cost of such an enterprise and keeping energy prices low, the dynamics of the events in the EU and in the world will gradually narrow down our field of opportunity. So now it is time for brave decisions.

Translation: Magdalena Stawicka

This text was created thanks to support of International Visegrad Found.

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